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Indexing Solutions For Retirement

FIAP International Seminar – FIAP/AMAFORE – Mexico City, October 2017

Copyright © 2017 by S&P Global. All rights reserved.

Aye M. Soe, CFAManaging Director, Global Research and Design – The Americas


Indexing Solutions For Retirement 2

Trends in Indexing1

2

3

4

Evolution of Index Solutions in Retirement

Target Risk

Target Date

STRIDE5The Next Generation6


3

Trends in Indexing1

2

3

4


Target Risk

Target Date



Trends in Indexing 4

• Shifting focus from individual investment products to investment solutions.

• Institutional investors increasingly demand solutions that address their specific needs, such as matching liabilities, reducing funding ratio volatility, and achieving absolute return targets.

• Shift from active to passive management, using index-linked investment vehicles (ETFs/ETPs)

• Efficient way to access exposure to asset classes and market segments beyond core equities and fixed income.

• Thinking more and more of risk factors or risk premia as the building blocks of asset allocation, rather than asset classes.

Outcome-Oriented SolutionsActive To Passive Factor-Based Asset Allocation

The following three patterns have developed in the past decade, which have reshaped investment management industry and asset allocation processes.

Source: S&P Dow Jones Indices. White Paper “ The Role of Multi-Asset Solutions in Indexing” 2013. Chart is provided for illustrative purposes.

http://spindices.com/documents/research/the-role-of-multi-asset-solutions-in-indexing.pdf


Evolution of Index Solutions 5

Source: S&P Dow Jones Indices. White Paper “ The Role of Multi-Asset Solutions in Indexing” 2013. Chart is provided for illustrative purposes.

Alpha

Beta

Pure Alpha

(Pure Manager

skills)

Outcome

Oriented

Solutions

Systematic Risk

Premia

Asset Class

Beta

Exogenous to

Indexation

Multi-Asset

Strategic Indices

Alternative Beta

Strategic Indices

Market

Benchmarks

Low

Cost,

Syste

matic F

acto

rs S

carc

e, M

anag

er

Skill

s

http://spindices.com/documents/research/the-role-of-multi-asset-solutions-in-indexing.pdf


6

Trends in Indexing1

2

3

4


Target Risk

Target Date



The Role of Index Solutions in the Retirement Landscape 7

• The Shift from DB to DC has put the investment burden on plan participants.

• What constitutes adequate investment? Wealth maximization versus income stability.

• Regulators, plan sponsors, and public and private managers have put different alternatives on the

table.

• Having an appropriate measurement of performance and evaluation framework is a major part of

the investment management process.

• Indices serve as yardsticks against which managers’ performance can be compared and their

effectiveness can be assessed.


Properties of a Good Benchmark

Bailey and Tierney (1998) outlined the following properties as desirable characteristics for benchmarks:

8

Source: Bailey, J., and D. Tierney. “Controlling Misfit Risk in Multiple-Manager Investment Programs.” Research Foundation of AIMR & Blackwell Publishers, 1998. Chart is provided for illustrative putposes.

Unambiguous

Investable

Measurable

Appropriate

Reflective of current

investment opinions

Specified in advance

Owned


From Theoretical Framework to Index Design 9

Source: S&P Dow Jones Indices LLC. Chart is provided for illustrative purposes.

Aligning index design with regulatory, investability, replicability constraints….

Theoretical Framework

Regulatory Constraints

Industry Considerations

Market Considerations

Final Index Design

Investment Objective

Type of Pension System

Investment Restrictions

Number of participants

Size of the pension market (AUM’s)

Existing Asset ClassExposures

Available InvestableInstruments/Asset Class

Proxy

Liquidity

Asset Allocation

Rebalancing Frequency

Max/Min Weights


Evolution of Index Based Retirement Solutions 10

1• Target Risk

2• Target Date

3• STRIDE (S&P Shift To Retirement Income & Decumulation)

Independent and appropriately designed benchmarks for the pension fund industry.


11

Trends in Indexing1

2

3

4


Target Risk

Target Date



Target Risk 12

Source: S&P Dow Jones Indices LLC.

• Most suitable for several countries in Latin America given the current structure of the pension system.

• The S&P BMV Mexico Target Risk Index Series - comprises four multi-asset-class indices, each

corresponding to a particular risk level.

• These indices are intended to represent stock-bond allocations across a risk spectrum from conservative to

aggressive, while considering the regulatory and investability constraints of local pension funds.


Mexico Target Risk Series 13

I. S&P/BMV Mexico Target Risk Conservative Index.

Emphasizes exposure to domestic short-term fixed income in order to avoid excessive volatility of returns.

II. S&P/BMV Mexico Target Risk Moderate Index.

Offers significant exposure to short- to mid-term fixed income, while also increasing opportunities for higher portfolio returns by increasing

exposure to equities.

III. S&P/BMV Mexico Target Risk Growth Index.

Increases the exposure to equities and also provides mid- to long-term fixed income exposure.

IV. S&P/BMV Mexico Target Risk Aggressive Index.

Emphasizes the exposure to equities, maximizing opportunities for long-term capital accumulation.

Provides exposure to fixed income, with allocations placed in longer-term maturity bonds.



Mexico Target Risk Series 14

Source: S&P Dow Jones Indices LLC. Data as of Nov. 1, 2016. Chart is provided for illustrative purposes.

4% 20% 25% 35%

86% 77% 72% 62%

10%3% 3% 3%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Conservative Moderate Growth Aggressive

Asset A

llocation

Equity Fixed Income Cash


36-Month Rolling Annualized Returns and Volatility 15

Source: S&P Dow Jones Indices LLC. Data as of Nov. 1, 2016. Chart is provided for illustrative purposes.

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lati

lity

(%

)

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alized

Retu

rn (

%)

Conservative Index

volatility

Return

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lity

(%

)

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alized

Retu

rn (

%)

Growth Index

Volatility

Return

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alized

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lati

lity

(%

)

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nu

alized

Retu

rn (

%)

Moderate Index

Volatility

Return

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Aggressive Index

Volatility

Return


16

Trends in Indexing1

2

3

4


Target Risk

Target Date



Target Date 17

AssetExposure

SecuritySelection

Expenses of

Underlying

Funds

Active Bets of

Underlying

Funds

Shift of

Allocations -

“Glide Path”

Allocation

Among

Asset

Classes

Choice of

Asset

Classes

Target

Date Fund

Active Risk

• The S&P Dow Jones Target Date Index Series is a family of multi-asset class indices, each corresponding to a particular target retirement

date.

• Each index provides varying levels of exposure to equities and fixed income, and each target date allocation is created and retired according

to a pre-determined schedule related to the respective target date.

Sources

of Target

Date

Fund

Active

Risk


18

How does one set the glide

path?


Benchmark Options 19

Source: S&P Dow Jones Indices LLC. White Paper “Benchmarking Target Date Funds: The S&P Target Date Index Series”.

Glide Path Consensus

Model Driven

• The underlying premise of target date strategy is a varying derisking glide path, shifting from a high equity risk level to a low equity risk level over time.

• Lets explore two options for benchmarking Target Date Funds:

http://spindices.com/documents/research/whitepaper-target-date-mar-2012.pdf


Survey - The U.S. Approach

• Significant differences in glide paths and asset class exposure across the target date fund universe can create difficulties in benchmarking

and defining passive exposure to the available universe.

• In the U.S., S&P Dow Jones Indices’ target date benchmark series extends traditional representative indexing into the growing target date

fund universe by establishing a new method for defining market consensus.

• Benchmark asset allocation is derived from a robust survey of target date fund peer groups with the allocations fully investable.

20

PassiveAsset Class

Representation

Consensus AssetClass Exposure

S&P TargetDate Index

Series

Measures impact of manager’s asset allocation decisions

Measures impact of manager’s security election decisions



S&P Target Date Index SeriesMethodology

21

Source: S&P Dow Jones Indices LLC. http://spindices.com/documents/methodologies/methodology-sp-target-date.pdf

Asset Class Eligibility


Distinguishing “To” and “Through”

• The S&P Target Date To and Through Indices offer stakeholders style-specific measures of the two prominent approaches to glide path

management within the target date fund universe.

• “To” funds have relatively conservative glide paths and aim to emphasize market risk sensitivity around the retirement date

• “Through” funds are relatively more aggressive and aim to be more sensitive to longevity risk at, and beyond, the retirement date.

22


Survey-Based Approach May Not Be Adequate for Latin America


Universe Size and Definition

Representative

ObjectivePeru 4 AFPs

Mexico 11

Afores

Chile 6 AFPs

Public/

Private


Model Driven Approach May Be More Reflective

Life-cycle, rules-based strategy, transitioning focus from index components representing growth assets to index components.

24


Based on a pre-set

Target Risk strategy.

To avoid subjectivity of model, thorough review of:

Theoretical Framework

Regulatory Environment

Industry Considerations

Market Considerations

Final Index Design


25

Trends in Indexing1

2

3

4


Target Risk

Target Date



Transition from wealth accumulation to

income generation


Challenges Facing Defined Contribution Participants 27

Source: S&P Dow Jones Indices LLC. Charts are provided for illustrative purposes.

How to earn enough and budget spending for retirement

How to select investments, rebalance and adjust for changing circumstances

How to transition from wealth accumulation to income generation

Innovations in plan design, such as auto enrollment & auto escalation have helped with this challenge.

The introduction of target risk, target date funds & other diversified investment alternatives has helped with this challenge.

The majority of plan participants lack access to in-plan income solutions or investments that integrate with out-of-plan income solutions.


The DC Landscape 28

Source: S&P Dow Jones Indices LLC. Charts are provided for illustrative purposes.

DC Participant

Risks

Budgeting to Save Enough

Developing a Long-Term Investment Perspective

Transitioning to Income

Generation

Longevity

Cost of Income

Market Returns

Inflation

Limited to no control over

results

Greater degree of

control over results


S&P STRIDE Framework 29

* TIPS-LDI stands for Treasury Inflation-Protected Securities – Liability Driven Investment. This part of the index hedges inflation as well as interest rate risk, two major drivers of uncertainty around retirement income affordability. Retirement income affordability means how much income can be acquired with a given amount of savings. The primary driver of uncertainty around this variable is the level of interest rates. All else equal, when rates are higher, income is cheaper, and vice versa.

Conventional TD Glide Path

TIPS-LDI* Allocation

A new risk management framework, where the risk being mitigated is the uncertainty of how much real income can be afforded…


Uncertainty of Returns Versus Uncertainty of Income Affordability 30

Monthly total returns of the S&P–BG Cantor 0-1 Treasury Bond Index and the TIPS-LDI index combination, divided by monthly change in the cost of GRIL (starting January 2015), from January 2003 – December 2014. See below for details of index combination.

Monthly total returns of the S&P–BG Cantor 0-1 Treasury Bond Index and TIPS-LDI index combination, January 2003-December 2014. See below for details of index combination.

Source: S&P Dow Jones Indices and Dimensional Fund Advisors. The TIPS-LDI index combination is constructed by weighting the S&P 7-10 year TIPS index and the S&P 30 year TIPS index to match the duration of GRIL (starting in January 2015).

Drawdown risk is not the only risk faced

by employees nearing retirement.

Uncertainty of income affordability is

also a risk.

MONTHLY TOTAL RETURNS

-20%

-10%

0%

10%

20%

2003 2005 2007 2009 2011 2013

S&P - BG Cantor 0-1 Treasury Bond Index TIPS-LDI Index Combination

MONTHLY % CHANGE IN AMOUNT OF INCOME PURCHASING POWER When viewed in terms of income

affordability, short-term bonds appear

more volatile and duration matched

TIPS become the low-risk asset.

-20%

-10%

0%

10%

20%

2003 2005 2007 2009 2011 2013

S&P - BG Cantor 0-1 Treasury Bond Index TIPS-LDI Index Combination


S&P STRIDE Components

• Innovative risk management - the uncertainty of future inflation-adjusted income is mitigated as each TD approaches (out to 2060 vintage).

• Conventional TD glide path of global equities and fixed income + “TIPS-LDI” allocation.

• Landing point at target date = 25% global equities + 75% TIPS-LDI.

• TIPS provide inflation hedge and duration of TIPS-LDI allocation matches that of a retirement income.

31

Source: S&P Dow Jones Indices LLC. Table is provided for illustrative purposes. TIPS-LDI: Treasury Inflation-Protected Securities, liability-driven investing.


Glide Path 32

Source: S&P Dow Jones Indices LLC. Chart is provided for illustrative purposes. TIPS-LDI: Treasury Inflation-Protected Securities, liability-driven investing.


Glide Path 33

• Decumulation begins at the retirement date.

• The index weight assigned to equityand TIPS reaches 25% and 75%, respectively.

• Note that a decline in equity may result in a lower equity total at the target date in the S&P STRIDE TIPS-Lockbox Series.

• Conventional target date glide path (stock and nominal bond indices).

• This phase lasts from 40 years before the target date to 20 years before the target date.

• The overall equity allocation decreases gradually and the overall nominal bond allocation increases gradually.

• This phase lasts for 20 years before the target date.

• Overall equity allocation continues to decline, nominal bond allocation also declines from its peak down to 0%. The index weight is gradually shifted from equities and nominal bonds into the set of TIPS indices, with the index weight assigned to these indices growing from 0% to 75%.

DecumulationAccumulation Transition

Source: S&P Dow Jones Indices LLC. Chart is provided for illustrative purposes. TIPS-LDI: Treasury Inflation-Protected Securities, liability-driven investing.


The Generalized Retirement Income Liability (GRIL) 34

• A retirement income liability is used in the STRIDE framework.

• Generalized Retirement Income Liability (GRIL) – defined as the hypothetical inflation-adjusted stream of cash flows

equal to USD 1 per year that starts at the target date and ends 25 years later.

• The cost of retirement income = Present Value (GRIL) The interest rates used to discount these future hypothetical cash

flows to the present are derived from the current U.S. TIPS curve.

• GRIL is expressed monthly, so the cost of income at time 𝑡 is given by:

𝑃𝐺𝑅𝐼𝐿,𝑡 =

𝑖=1

300

(1

12) × 𝑒− ෨𝑅𝑖,𝑡(𝑇𝑖−𝑡)

where:

𝑡 = the calculation date;

𝑇𝑖 = the month and year the 𝑖th payment is made;෨𝑅𝑖,𝑡 = the discount rate corresponding to maturity (𝑇𝑖 − 𝑡)


The Cost of GRIL 35

Source: S&P Dow Jones Indices LLC. Chart is provided for illustrative purposes.


The Cost of GRIL 36


Quantifying the cost (present value) of GRIL has a few important benefits:

1. We can measure duration of GRIL, which is used as the target duration of the TIPS allocation in the index. This process is important because:a. It hedges the TIPS allocation to interest rate risk on a monthly basis.

b. It enables us to roughly match the duration of retirement income (the liability represented by GRIL) with the duration of assets meant to collateralize the provision of retirement income, or to provide it directly, in the future.

2. One can calculate how much income would have historically been hypothetically afforded by any STRIDE index. Of course hypothetical illustrations using indices do not account for investment expenses, and it is not possible to invest directly in an index. But such illustrations may nevertheless be valuable for what they demonstrate, and we show several in the following slides.


Index Characteristics and Highlights 37

• Innovative risk management framework: uncertainty of the affordability of future inflation-adjusted income is mitigated and lowered, as each target date approaches.

• Conventional target date glide path that includes global equities and global fixed income, and is combined over time with a risk management component—the “TIPS-LDI” allocation.

• Landing point at target date: 25% global equities/75% TIPS-LDI.

• Inflation hedging with TIPS exposure.

• Monthly duration hedging: the duration of the TIPS-LDI allocation matches that of a retirement income liability.


38

The Role of Multi-Asset Solutions in Indexing1

2

3

4


Target Risk

Target Date



The Next Generation of Life Cycle Benchmarks 39

Incorporation of Smart Beta Strategies

• Return Enhancing Factors • Risk Reducing Factors

ACCUMULATION DECCUMULATION

Source: S&P Dow Jones Indices LLC and/or its affiliates. Data as of Sept. 29, 2017. Chart is provided for illustrative purposes.

Broad-Based Index

Selection of the

least volatile

stocks.

Low Vol or Minimum Volatility

Strategies

Momentum, Growth:

Historically provided

higher risk-adjusted

returns than the market


Managed Equity Volatility Indices 40

Source: S&P Dow Jones Indices LLC. Data as of Sept. 29, 2017.

S&P 500 Low Volatility S&P 500 Minimum

Volatility

S&P 500 Low Volatility

High Dividend

Index Beta to Market

S&P 500 Low Volatility 0.65

S&P 500 Minimum Volatility 0.74

S&P 500 Low Volatility High Dividend 0.80

Market is represented by the S&P 500


Return Enhancing Indices 41

Source: S&P Dow Jones Indices LLC. Data as of Sept. 29, 2017. Charts are provided for illustrative purposes.

S&P 500

MomentumS&P 500 Pure

Growth

Index 1-Year Beta to Market (S&P 500)

S&P 500 Momentum 1.06

S&P 500 Pure Growth 1.14


Materials & Website 42

See our white papers, FAQs, and other STRIDE content at:

http://spindices.com/index-family/multi-asset/sp-stride


Thank You 43

Aye M. Soe, CFA

Managing Director, Global Research and Design - The Americas


General Disclaimer

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Performance Disclosure

The S&P/BMV Mexico Target Risk Conservative Index, S&P/BMV Mexico Target Risk Moderate Index, S&P/BMV Mexico Target Risk Growth Index, and S&P/BMV Mexico Target Risk Aggressive Index were launched on November 1, 2016. The S&P STRIDE Indices were launched on January 11, 2016. The l&P 500 Low Volatility Index was launched on 04/04/2011. The S&P 500 Momentum Index was launched on 11/18/2014. All information presented prior to an index’s Launch Date is hypothetical (back-tested), not actual performance. The back-test calculations are based on the same methodology that was in effect on the index Launch Date. Complete index methodology details are available at www.spdji.com.

S&P Dow Jones Indices defines various dates to assist our clients in providing transparency. The First Value Date is the first day for which there is a calculated value (either live or back-tested) for a given index. The Base Date is the date at which the Index is set at a fixed value for calculation purposes. The Launch Date designates the date upon which the values of an index are first considered live: index values provided for any date or time period prior to the index’s Launch Date are considered back-tested. S&P Dow Jones Indices defines the Launch Date as the date by which the values of an index are known to have been released to the public, for example via the company’s public website or its datafeed to external parties. For Dow Jones-branded indices introduced prior to May 31, 2013, the Launch Date (which prior to May 31, 2013, was termed “Date of introduction”) is set at a date upon which no further changes were permitted to be made to the index methodology, but that may have been prior to the Index’s public release date.

Past performance of the Index is not an indication of future results. Prospective application of the methodology used to construct the Index may not result in performance commensurate with the back-test returns shown. The back-test period does not necessarily correspond to the entire available history of the Index. Please refer to the methodology paper for the Index, available at www.spdji.com for more details about the index, including the manner in which it is rebalanced, the timing of such rebalancing, criteria for additions and deletions, as well as all index calculations.

Another limitation of using back-tested information is that the back-tested calculation is generally prepared with the benefit of hindsight. Back-tested information reflects the application of the index methodology and selection of index constituents in hindsight. No hypothetical record can completely account for the impact of financial risk in actual trading. For example, there are numerous factors related to the equities, fixed income, or commodities markets in general which cannot be, and have not been accounted for in the preparation of the index information set forth, all of which can affect actual performance.

The Index returns shown do not represent the results of actual trading of investable assets/securities. S&P Dow Jones Indices LLC maintains the Index and calculates the Index levels and performance shown or discussed, but does not manage actual assets. Index returns do not reflect payment of any sales charges or fees an investor may pay to purchase the securities underlying the Index or investment funds that are intended to track the performance of the Index. The imposition of these fees and charges would cause actual and back-tested performance of the securities/fund to be lower than the Index performance shown. As a simple example, if an index returned 10% on a US $100,000 investment for a 12-month period (or US $10,000) and an actual asset-based fee of 1.5% was imposed at the end of the period on the investment plus accrued interest (or US $1,650), the net return would be 8.35% (or US $8,350) for the year. Over a three year period, an annual 1.5% fee taken at year end with an assumed 10% return per year would result in a cumulative gross return of 33.10%, a total fee of US $5,375, and a cumulative net return of 27.2% (or US $27,200).

http://www.spdji.com/

http://www.spdji.com/

FIAP International Seminar FIAP/AMAFORE Mexico City ... · Data color order: Complimentary colors:...

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